SORL Auto Parts, Inc. (SORL) Flash Alert Rating: Strong Sell Price Target: $1.50 Date: December 20th, 2016 This research report reflects the opinions of Cliffside Research. We have based our opinions on facts and evidence collected and analyzed, all of which we set out in our research reports to support our opinions. This is not an offer to sell or a solicitation of an offer to buy any security. We strongly recommend that you do your own due diligence before buying or selling any security, and each investor must make any investment decision based on his/her judgment of the market and based upon all available information. At any time, you should presume that the principals of Cliffside Research and/or Cliffside Research clients and/or investors hold trading positions in the securities profiled on the site and therefore stands to realize significant gains in the event that the price of the stocks covered herein rises or declines in conjunction with our investment opinion. See our important full disclaimer titled “Terms of Service” at the bottom of this report.

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Summary:

The stock looks cheap at 5x earnings but in reality the stock deserves a 2x multiple at best because, in our opinion, it is uninvestable.

A recent "acquisition" of a factory has put $77.5mil in SORL cash into the coffers of the Chairman & CEO's own company. Seven months after the transaction SORL still awaits documents showing actual ownership.

CEO & family are using SORL as their own personal piggy bank, securing over $140mil in loans with guarantees and cash deposits made by SORL shareholders.

Investors in SORL have no legal recourse in China and are minority shareholders. In effect, the CEO can do whatever he wants with the cash.

From auditors, to bankers, to China frauds, SORL has many associations that put it in bad company. Where there's smoke, there's fire.

Overview:

SORL Auto Parts, Inc. (NASDAQ:SORL) is a China based manufacturer of automotive brake systems and other parts for commercial vehicles including heavy-duty trucks and buses, passenger vehicles and rail. The company came public in 2004 via a reverse takeout (RTO) of a US listed shell company along with a slew of other China based companies.

During the period between 2004 - 2009 many Chinese companies came public in the US using this reverse merger method, which allowed for quicker listing and fewer regulatory hurdles. It turns out that many of these companies were straight-up frauds. So when SORL suddenly had a pop and their valuation doubled in a few months, our interest was peaked.

Post our review of their business it appears investors in SORL are ignoring several significant risks. Since there is no legal recourse for US investors and there is a high probability of fraudulent activity within these companies, we believe Chinese RTO's are simply uninvestable. In our opinion, SORL is rightfully included in this list of uninvestable securities.

Cheap For A Reason:

Time To Pump The Brakes On SORL Auto Parts Inc. (SORL)

We are issuing a “flash alert” on SORL Auto Parts, Inc. (SORL) with a STRONG SELL rating and a $1.50 Target.

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SORL is guiding to $14.5mil in net income for 2016, or about 75c per share. At current valuation the stock is trading about 5x earnings. On the surface this may seem cheap, but cheap relative to what? For most of the year the stock has been trading for 2-3x trailing 2015 earnings of 69c.

First we should point out that legitimate companies very rarely, if ever, trade at these kind of low multiples. The same way you should know a company likely has a problem when they pay a 20% dividend, you should also know that they likely have a problem when they trade 2x earnings. That said, if the stock were to trade with a 2.5x P/E on 2016 eps the stock would be $1.88, or roughly 50% lower.

It would be easy to compare SORL to a US auto supplier but this would be a mistake because a US company they are not. When you look at other micro cap US listed Chinese companies you realize that they are pretty much all perennially cheap, and for good reason. As the old saying goes, when something appears too good to be true, it usually is. The truth is, as cheap as SORL appears to be, it's actually very expensive in comparison to recent history.

There are several reasons why US listed micro cap Chinese companies are perennially cheap but we'll focus on 3 main reasons.

1. Complex ownership structure 2. No legal recourse 3. High risk of fraudulence

One of the oddities of US listed Chinese companies that makes them much different from their US counterparts is their complex ownership structure. China does not allow direct foreign investment in Chinese companies. However, this has not stopped investors from attempting to invest in them. Foreigners have worked with Chinese companies for years devising ways to gain access to the cash flows of those companies in exchange for capital. China has largely allowed this to happen with a watchful eye. It is not uncommon for Chinese companies to create joint ventures based in Hong Kong, the Cayman or Virgin Islands for the purpose of allowing direct foreign "ownership" in them. The result is complex and confusing ownership structures that are typically best left to the most astute investors. Even then these investments are not without significant risk.

Foreign investment in Chinese companies ignores the obvious. China doesn't want foreigners to actual have ownership rights in Chinese companies. This means you effectively have no legal recourse. Additionally, we doubt the current political environment likely increases China's concern for US investors in Chinese companies. This gets to the heart of what it is that you actually "own" when you invest in SORL and it also applies to any US listed Chinese company. If you cannot enforce your rights as a

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shareholder than what do you really own? Ownership is based on control. If you have no control, you have no ownership.

With this legal vacuum in place aside complex and confusing ownership structures, the door to fraud has been left wide open and executives of these companies have been all too willing to step on through. US investors have willingly handed over billions of dollars to these companies. They're half a world away and protected by a government who couldn't care less about the rights of US investors. In the past five years dozens of US listed Chinese companies have been accused of fraud and in retrospect it makes total sense. The phrase "taking candy from a baby" comes to mind. As we said earlier, ownership is about control. So let's see what investors in SORL control.

The company was original founded by current Chairman and CEO Xiao Ping Zhang and his brother Xiao Feng Zhang in 1987. Xiao Feng Zhang is currently a member of the board and was the COO from 2004-2010. The Chairman/CEO's wife Shu Ping Chi is also a member of the board of SORL. Combined these three individuals own 58.8% of SORL stock. The Ruili Group holds another 10% minority holding. The Zhang family is the controlling shareholder of the Ruili Group. Combined this puts the Zhang family in control of 68.8% of SORL. This puts them in complete control of SORL as a majority shareholder and effectively makes US shareholder voting rights meaningless. The family can choose to do whatever they like with SORL shareholder money.

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Where's The Money?

As any investor knows, investing is about making money. SORL currently only has $7.5mil in cash on its books. It claims to be a highly profitable, high cash flow company so where did all the money go? It certainly has not gone to investors. Between 2009 and 2016 SORL made approximately $117.3mil from operating activities.

Source: Bloomberg

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We won't hold you in suspense any longer. The vast majority of the cash has gone back to Chairman & CEO Xiao Ping Zhang and his family. In 2010 they spent $25mil to acquire business assets from the Ruili Group. Remember, Ruili Group = Xiao Ping Zhang & family.

“On August 31, 2010, the Company, through the Joint Venture, executed an Agreement to acquire the assets of the hydraulic brake, power steering, and automotive electrical operations of the Ruili Group (the "Seller", a related party under common control)...the purchase price was RMB 170 million, or approximately USD$25 million.”

~SORL 10K, 3/29/11, pg. 27

This year they spent another $77.5mil in cash to purchase another Ruili Group asset.

“On May 5, 2016, the Company entered into a Purchase Agreement (the "Purchase Agreement") with the Ruili Group through Ruian, a related party under common control, pursuant to which the Company agreed to purchase the land use rights and factory facilities located at No. 2666 Kaifaqu Avenue, Rui'an Economic Development Zone, Rui'an City, Zhejiang Province, the People's Republic of China (the "Development Zone Facility"). In exchange for the Development Zone Facility, the Company will transfer to the Ruili Group the land use rights and factory facilities of the Dongshan Facility that Ruian currently owns, plus RMB501,000,000 (approximately $77,540,000) in cash. The total floor areas of the Dongshan Facility and the Development Zone Facility are 58,714 square meters and 157,619 square meters, respectively.”

~SORL 10Q, 5/16/16, pg. 20

These two transactions along with some other purchases of capital equipment have exhausted most of SORL's cash balance, leaving SORL with a paltry $7.5mil currently on its balance sheet. We took a closer look at exactly what it is that SORL shareholders accomplished with the acquisition of these assets, and in our opinion it's not a great deal for them.

To better understand the situation, we reviewed SORL's SEC filings back to 2004. In September 2007 the company purchased a factory from the Ruili Group for ~$20mil.

“On September 28, 2007, Ruili Group Ruian Auto Parts Co. Ltd., a subsidiary of the Company purchased land rights, a manufacturing plant, and an office building from Ruili Group Co. Ltd., a related party, for an aggregate purchase price of approximately RMB152 million (approximately US$20.2 million).”

~SORL 10K, 3/27/08, pg. 36

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Based on our research we believe that the property purchased in 2007 is the "Dongshan Facility" noted above that was just sold back to Ruili Group. The Dongshan Facility has a floor area of 58,714 square meters. This property was sold back to Ruili Group for $19.1mil as part of the "Development Zone Facility" purchase. That along with an additional $77.5mil in cash was used to purchase the 157,619 square meter Development Zone Facility for a total purchase price of $95.6mil. This appears to add production capacity of about 100,000 square meters, but it turns out to be a lot less. SORL was already leasing over 89k square meters of the Development Zone Facility.

“The Company is currently leasing 89,229 square meters of the Development Zone Facility from Ruili Group for its brake systems business...”

~SORL 10Q, 5/16/16, pg. 20

The production capacity of SORL prior to the acquisition was the Dongshan Facility consisting of 58,714 square meters and 89,229 square meters of the Development Zone Facility that SORL leased from Ruili Group.

Total square meters of production capacity prior to acquisition of the Development Zone Facility = 58,714 + 89,229 = 147,943 square meters.

By purchasing the Development Zone Facility they added less than 10k square meters of production capacity.

157,619 - 147,943 = 9,676 square meters of added production capacity post acquisition of the Development Zone Facility.

The acquisition of the Development Zone Facility from Ruili Group (controlled by the CEO) added very little net capacity to SORL but it was a very efficient way to transfer $77.5mil in SORL shareholder cash into the coffers of Ruili Group, a firm privately controlled by CEO & Chairman Xiao Ping Zhang and his family.

SORL The Piggy Bank:

We believe Chairman Xiao Ping Zhang, his brother Xiao Feng Zhang and his wife Shu Ping Chi are using SORL shareholder money as their own personal piggy bank. Below is a list of guarantees and cash deposits made by SORL on behalf of Ruili Group and associated entities beginning in 2013. To date SORL shareholders have been on the hook for a total of $140.5mil for loans made to either the Ruili Group or to a relative of the Chairman's wife.

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We believe this kind of activity would be unacceptable for a US based company. We consider these transactions highly unethical and at an absolute minimum they are cause for serious conflicts of interest. Unfortunately since the company is located in China and controlled by the Chairman there appears to be very little SORL shareholders can do about the situation. This is a good example of why no matter how "cheap" SORL appears, it's never really cheap when considering the potential for an entire loss on investment. Chinese reverse merger companies are simply uninvestable. If this stock were such a bargain, than certainly professional money managers would want to own it. SORL has no meaningful institutional ownership.

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Auditor Problems:

Up until July 2013, SORL was audited by EFP Rotenberg, LLP. EFP was banned from auditing US listed Chinese companies in 2014 based on audits of Universal Travel Group. UTG was another Chinese reverse merger company that has since been delisted from the NYSE. In the SEC's administrative proceeding against SORL's former auditor it said the following:

“Rotenberg did not have adequate policies and procedures as to client acceptance at the time it approved UTG as a client, which allowed the final acceptance of the UTG engagement without attempting to make any inquiries of the Predecessor Auditor.”

and this...

“Rotenberg's...failure to abide by PCAOB standards in the UTG audit... involved repeated instances of unreasonable conduct.”

and this...

“Rotenberg shall not issue any audit report, accept any audit engagement, or play a substantial role in the preparation or furnishing of any audit report for any issuer or registrant, U.S. or foreign, that files with the Commission.”

The SEC also stated that Rotenberg "Failed to obtain sufficient competent evidence, exercise due professional care, exhibit heightened professional skepticism, and control the confirmation process." Additionally the firm was fined $50k. Other firms audited by EFP Rotenberg are all trading on the OTC now.

China Gengsheng Minerals (OTC:CHGS) China Internet Cafe Holdings Group (OTCQB:CICC) China Digital Animation Development (OTC:CHDA) Tanke Biosciences (OTCPK:TNBI) First China Pharmaceutical (OTC:FCPG) Universal Travel Group (OTCPK:UTRA)

We wondered if the SEC proceeding against Rotenberg's audit of UTG was a company specific issue. Perhaps the case was an isolated incident. We dug further and found that this is highly unlikely. In 2011 the PCAOB conducted an inspection of EFP Rotenberg. In that inspection, the PCAOB found that the firm had deficiencies related to identifying proper GAAP accounting and proper revenue audit procedures.

“The inspection team identified what it considered to be audit deficiencies. The deficiencies identified in the audit reviewed included deficiencies of such

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significance that it appeared to the inspection team that the Firm did not obtain sufficient competent evidential matter to support its opinion on the issuer's financial statements. Those deficiencies were – (1) the Firm's failure to identify, or to address appropriately, a departure from GAAP that related to a potentially material misstatement in the audited financial statements concerning a subsidy; and

(2) the failure to perform sufficient audit procedures related to revenue.”

These appear to be issues that the PCAOB was well aware of. They note in this inspection, that in a prior inspection from 2006 they had warned Rotenberg of the potential for fraud.

“During an inspection of the Firm conducted in 2006, the PCAOB inspection team brought to the Firm's attention that the Firm's procedures appeared not to provide sufficient assurance that the Firm performed audit procedures to test journal entries and other adjustments for evidence of possible material misstatements due to fraud. An appropriate approach to monitoring would have resulted in the Firm avoiding this deficiency in audits performed after they were brought to the Firm's attention, yet the same deficiency was noted in this inspection.”

SORL's new auditor, MaloneBailey isn't much better. MaloneBailey has stated that in their audits they are basically taking the word of management in regards to internal controls over financial reporting.

“We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting.”

~SORL 10K, 3/31/15, pg. 33

Not to be outdone by Rotenberg, in the PCAOB's inspection of MaloneBailey in 2014 they also had some harsh comments regarding deficient accounting standards at MaloneBailey.

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“Certain of the deficiencies identified were of such significance that it appeared to the inspection team that the Firm, at the time it issued its audit report, had not obtained sufficient appropriate audit evidence to support its opinion that the financial statements were presented fairly, in all material respects, in accordance with applicable financial reporting framework and/or its opinion about whether the issuer had maintained, in all material respects, effective internal control over financial reporting ("ICFR"). In other words, in these audits, the auditor issued an opinion without satisfying its fundamental obligation to obtain reasonable assurance about whether the financial statements were free of material misstatement and/or the issuer maintained effective ICFR.

Whether or not associated with a disclosed financial reporting misstatement, an auditor's failure to obtain the reasonable assurance that the auditor is required to obtain is a serious matter. It is a failure to accomplish the essential purpose of the audit, and it means that, based on the audit work performed, the audit opinion should not have been issued.

Audit A ■ The Firm failed to perform sufficient procedures to test the issuer's acquisition of substantially all of the assets and certain liabilities of a related party ■ The Firm failed to perform sufficient procedures to test the occurrence and valuation of revenue.

Audit B ■ The Firm failed to perform sufficient procedures to test the occurrence and valuation of revenue by haphazardly selecting a sample of revenue transactions to test these assertions. ■ The Firm failed to perform sufficient procedures to test the valuation of inventory”

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Source: PCAOB 2014 Inspection of MaloneBailey, pg. 10

Source: PCAOB 2014 Inspection of MaloneBailey, pg. 11

Incredibly, much of the same language was used in describing accounting deficiencies by MaloneBailey in the inspection that took place just one year before in 2013. So it would

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appear they were unable to make improvements in audit procedures over the course of the year between inspections.

“Certain of the deficiencies identified were of such significance that it appeared to the inspection team that the Firm, at the time it issued its audit report, had not obtained sufficient appropriate audit evidence to support its opinion that the financial statements...”

~PCAOB 2013 Inspection of Malone Bailey, pg. 3

MaloneBailey also audits other U.S. listed Chinese companies. The only company not currently listed on the OTC is CCRC.

China Runji Cement (OTCPK:CRJI) China Century Dragon Media (OTC:CCDM) Longhai Steel (OTC:LGHS) China TMK Battery Systems (OTCPK:DFEL) China Media (OTCPK:CHND) China Electric Motor (OTCPK:CELM) China Customer Relations Centre (NASDAQ:CCRC)

Friends In Low Places:

SORL originally was brought public via reverse merger with a shell company called Enchanted Village, Inc. The shell was supplied by a firm called Keating Investments, LLC owned and operated by Timothy J. Keating. In a piece of marketing material from 2005, Keating proudly displays that they were also the firm that provided the shell for now infamous Puda Coal, Inc.

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In 2011 Puda Coal was exposed as a massive fraud when the Chairman of the company, Ming Zhao, essentially stole all the operating assets of the company by transferring ownership of the company to himself without shareholder approval. He then proceeded to sell off the operating assets and recklessly levered up the company with $530mil in debt. In 2015 the SEC won a $250mil judgment against Chairman Ming Zhao and CEO Liping Zhu. "Here, defendants came into the U.S. public markets to raise capital for their coal mining venture and then absconded with the proceeds, leaving the shareholders of Puda with an empty shell," the SEC wrote. "In short, they stole the coal company for their own purposes and fraudulently used the U.S. capital markets to finance their expansion plans."

In Puda Coal's very first quarterly conference call with US investors as a public company, the call was led by a "T. Keating." We presume this is the same T. Keating of Keating Investments, LLC. We were also able to connect Puda directly to SORL. In September of 2005, Puda and SORL traveled together for nearly three weeks on a whirlwind tour of the US and Canada. Keating Investments sponsored the roadshow.

Keating found the shell for SORL but they weren't the bankers. SORL was taken public by Maxim Group as sole bookrunner and Chardan Capital Markets as co-manager. Ellenoff Grossman & Schole acted as counsel to the underwriter. Besides SORL, all the other companies Ellenoff Grossman & Schole have been involved with are delisted, bankrupt, or have gone dark.

Chardan Capital Markets has had a particularly controversial and troubling past. Kerry Propper is the former CEO of Chardan (now non-executive chairman). His father Dr. Richard Propper runs a similarly named venture capital group, Chardan Capital, in California. In the 1990s, Dr. Propper settled with the SEC over disclosure problems, and in 2005 and 2007 he was sued by the federal government for defrauding the Small

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Business Administration out of $32 million. He ended up with a fine. Kerry Propper also received a small fine.

Dr. Propper & son were also sued by investors of a Chinese firm called Huiheng Medical. The CFO of that company stated on a call with investors that the company was "spending substantial amounts of money paying bribes to officials in control of the Chinese hospitals," according to the suit. The lawsuit also alleged that Huiheng prepaid firms controlled by its CEO, who holds most of Huiheng's stock, for material that was never delivered. Later they would write off the debts. The case was later settled.

Business Operations:

SORL is a China based manufacturer of automotive brake systems and other parts for commercial vehicles including heavy-duty trucks and buses, passenger vehicles and rail. 81.7% of sales are to the commercial vehicle industry and the majority of these sales are to the heavy-duty truck segment. 18.3% of sales are to the passenger vehicle industry. Over 80% of sales come from braking systems while "other parts" includes power steering, air controlling systems and automotive electrical parts. SORL sells parts into three main supplier categories including Chinese original equipment manufacturers (OEM's), Chinese aftermarket and international markets, according to the company.

Below are pictures of SORL's factory. The equipment looks old and outdated. Note the areas near the floor. Most of the equipment is banged up with scratches, dents and years of neglect. The bright yellow caution lines along the floor denoting various sections has nearly worn away. The word that immediately came to mind when we first saw these photos was "grimey."

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“Grimey: From ‘grime;’ something very dirty or filthy, caked with dirt. Marked by abjectness stemming from neglect.”

Note the station to the left and the barely visible yellow caution lines along the floor. Most of this equipment looks 20 years old.

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Signage in the upper left corner confirms this is SORL.

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More "grimey" equipment & parts.

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SORL's version of "inventory management."

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A look under the table is not pretty.

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A close up of SORL's high performance auto parts.

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Here's a look at SORL's distribution network.

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In comparison, here is what some of their competitor's factories look like.

Guangxi Yuchai

The equipment looks far cleaner and newer.

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Shanxi Fashite

Clean equipment and floors. Note the bright yellow caution line is clearly visible.

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Haerbing Dongan Automobile

Again, very clean floors and equipment. Highly professional attire.

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US Factories:

Nexteer

Equipment looks new and well organized.

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Delphi (DLPH)

Floors you could eat off.

What's clear from these pictures is that to get SORL equipment standards up to the standards of the competition, it would take several millions of dollars in capex. This is money they no longer have post the acquisition of the Development Zone Facility from Ruili.

SORL’s a Top 100 Supplier?

In every press release in the “about” section SORL claims they are a top 100 auto component supplier in China.

“SORL is listed among the top 100 auto component suppliers in China”

~8K, 11/15/16

SORL was a top 100 supplier in China from 2007 to 2009. After 2009 we could find no evidence to support the claim that SORL is a top 100 auto component supplier in China.

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In 2009 the company supposedly produced revenue of $141mil and that supposedly increased to $219mil in 2015. Despite the increase, our review of top 100 auto suppliers in China yielded no results for SORL after 2009.

In 2007 SORL was ranked 37th…

In 2009 SORL was ranked 71st…

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Beginning in 2010, SORL is no longer on the list…

In 2011 SORL is not on the list…

In 2013 SORL is not on the list…

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In 2015 SORL is not on the list…

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We were unable to find the top 100 China component supplier list for the years 2012 and 2014. That said, we are fairly confident that if they weren’t on the list in any other year since 2009, it is unlikely they made the list in these other years.

In 2012 China’s Quality Inspection Bureau produced a list of companies that exhibited “severe misconduct” by forging, altering, or buying/selling inspection certificates for the product they produced. SORL is the 2nd name on the list.

Slowly Going Dark:

Over time, SORL appears to be communicating and engaging with US investors less and less. As they do so it becomes more difficult to conduct proper analysis of the business. For example, when the company first came public, Chairman and CEO Xiao Ping Zhang was present on quarterly earnings calls. The last call on which we could confirm his attendance was in Q3 2008. We could find no example of any other call he has attended since that time. In fact, neither the CEO or CFO Ms. Zong Yun Zhou attend conference calls. The calls are hosted by COO Jinrui Yu and Accounting Manager Min Kan Lin. We believe the company has disengaged from SORL investors.

We found more evidence of this in reviewing the company’s websites. The company has spent very little time or effort maintaining their websites. The US investor relations

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website has been poorly maintained as can be seen below. Several copyright dates haven’t been updated in years.

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SORL’s been traded on Nasdaq since 2006. Apparently ten years isn’t enough time to add disclaimer, privacy policy and terms of use date to their US website.

SORL Doesn’t Own The Factory:

Investors in SORL don’t own the factory or the property that the factory is on that they just paid $96.5mil for and in our opinion they never will. In China you can’t “own” property in the traditional sense that we are accustomed to in the US. The government ultimately owns all the property and buildings. What you can own in China are land use rights. When SORL purchased the Development Zone Facility from the CEO’s Ruili Group they paid $96.5mil for the factory and the land use rights. Seven months later, ownership and land use rights have not been transferred from Ruili Group to SORL despite the fact that the transaction was completed and most of the cash has been transferred to Ruili.

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“On May 5, 2016, the Company entered into a Purchase Agreement with the Ruili Group through Ruian, pursuant to which the Company agreed to exchange the Dongshan Facility plus RMB501 million (approximately $76.5 million) in cash for Development Zone Facility…as of September 30, 2016, total amount of RMB481 million (approximately $73.5 million) was paid to the Ruili Group…as of the filing date, the Company has not obtained the land use right certificate nor the property ownership certificate of the buildings of the Development Zone Facility.” (emphasis added)

10Q, 11/14/16, pg. 14

In our opinion, it is highly unlikely that SORL will ever own the building and land use rights. Our confidence stems from the fact that SORL has never owned any building or land use rights. Since SORL’s founding in 2004, they have mainly operated out of two facilities. Those facilities are:

1. The Dongshan Facility 2. The Development Zone Facility

Both of these facilities were bought from Ruili Group. The Dongshan Facility was purchased, from Ruili Group in 2007 for approximately $20mil. SORL was leasing space in the Development Zone Facility prior to purchase. In this recent transaction, in exchange for the Development Zone Facility SORL sold the Dongshan Facility back to Ruili Group for $19.1mil and paid an additional $77.5mil in cash. However, what is very clearly stated in SEC filings is that SORL technically never owned the Dongshan Facility or the land use rights for that property.

“The Company has never obtained the land use right certificate nor the property ownership certificate of the building for the Dongshan Facility.”

10Q, 11/14/16, pg. 19

Again, the Dongshan Facility was purchased in 2007. Nine years later SORL still didn't technically own a factory and land use rights that they paid $20mil for with investor cash! So the obvious question is, why is it taking so long to transfer the ownership rights from Ruili Group to SORL? According to the company's SEC filings, they were negotiating taxes owed on the transaction with the Chinese government.

“The Company has been negotiating with the government for a reduction in or exemption from the tax being sought by the government in connection with the transfer of the land use rights, and pending resolution of that issue, we have deferred accrual or payment of the tax. Due to the lack of resolution of that issue, the land use right certificate and the property ownership certificate have not been issued to the Company. There is no assurance that we can conclude the

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negotiations with the government and obtain a favorable result. We plan to conclude negotiations with the government and to obtain the land use rights certificate as soon as practicable.”

10K, 3/31/14, pg. 30

So they were in negotiations over taxes for nine years and never resolved the issue. Then they sold the property back to Ruili Group. This seems like an awfully long time for a negotiation. After allowing SORL to slide with this explanation for several years, the SEC was getting curious too beginning back in 2011.

“We note your disclosure that you have not yet obtained the land use right certificate however, you have applied to obtain the land use right certificate. In light of this fact, please explain to us why you believe that it is appropriate to record an asset for this land use right as of December 31, 2010 and 2009. As part of your response, please explain to us why you believe that the amount of the asset is recoverable at December 31, 2010.”

~SEC letter to SORL, 8/22/11

Post this letter, SORL began providing more detail about the Dongshan Facility transaction. In a letter to the SEC in 2014 responding to more questions about the transaction, we learn that the amount of taxes owed under dispute is at most 3% of the transaction or $724,580. Below is an excerpt of SORL's response to the SEC regarding the Dongshan Facility.

“Specifically, the Company reserved the relevant tax amount of RMB 4,560,000 (approximately $724,580). This amount was determined based on a 3% tax rate on the consideration paid for the land use right in the transaction, which the Company considered as the most probable amount of tax liability.”

~SORL response to SEC, 9/11/14

They spent nine years "negotiating" over what they claim in their own correspondence with the SEC what they consider to be an "immaterial amount." We agree that it is an immaterial amount, so why did they fight paying it for nine years? By refusing to pay taxes on the Dongshan facility, the company was unable to obtain paperwork showing SORL as the rightful owner of the factory and land use rights. Rights conveniently owned by the CEO over this period.

We have a theory for what we believe is happening here. Since the CEO and his family are the controlling shareholders of both Ruili Group and SORL, he sees the transaction as an intercompany transaction. It is our opinion that essentially, he feels to pay taxes to the government for a transfer of ownership from one of his entities, to another of his

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entities is a waste of his money. In other words, in his mind he owns the property whether the paperwork is in the name of Ruili Group or SORL, so why pay taxes on it?

What this obviously ignores is the legal rights of SORL shareholders. Without paperwork showing SORL as the rightful owner of the property, they have no legal claim on it. Forget the unwillingness of the Chinese government to help foreign shareholders. Forget the fact that in effect SORL shareholder votes don't count. Forget that these companies are beyond the SEC's reach. Even if they weren't, SORL shareholders still wouldn't have any paperwork showing they own any factory, ever. This again highlights why this company is uninvestable and deserves a severely depressed multiple. As we stated earlier, you don't own what you can't control.

How Can You Trust Their Financials?

When reviewing the list of executive officers and directors from the most recent proxy statement it wasn't hard to see that something wasn't right. Ms. Yu Hong Li is missing from the list. Ms. Yu Hong Li has been a member of the board for two years and been the Chairperson of the Audit Committee since June 2015. According to her profile she has more than 25 years of experience in accounting and auditing. The company claims "Ms. Li qualifies as an audit committee financial expert under Nasdaq rules and SEC rules and regulations," yet somehow she and the rest of the board apparently failed to recognize she is not listed as a director in the list below.

In addition, the share sum for Xiao Ping Zhang, Xiao Feng Zhang and Shu Ping Chi is incorrect. The total sum should be 11,359,403. These errors have been left uncorrected for two years. We find this extremely disturbing. If the company can't even put together a proper list of its' executives and directors and the number of shares owned by those individuals, how can we trust the rest of their financials? This lack of attention to detail is yet another example of a management that appears to have disengaged from the investor base. Who knows what other "errors" may lurk in their financial statements?

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In Conclusion:

SORL is amongst a slew of US listed Chinese reverse merger stocks that came public between 2004-2009, a period brimming with fraudulent activity in the category. The reverse merger structure allowed Chinese companies to list in the US with lower regulatory hurdles. In addition, the amount of fraudulent activity clearly shows that very little due diligence was performed on many of these companies. These factors in combination with complex ownership structures and a lack of legal recourse exacerbate a situation ripe with fraud.

As a result, SORL has been lumped-in with this group and its' valuation reflects this. The stock looks perennially cheap, typically trading between 2-3x earnings just earlier this year. Recently investors have driven the stock closer to 5x earnings despite the fact that the risks associated with the company have not changed. In our opinion the company is simply uninvestable.

To own shares in SORL, one must ignore the fact that in addition to a lack of legal recourse, they are minority shareholders. As a result, their voting rights simply do not count. The company can do, and does do, whatever they like with minority shareholder cash. Recently the company unilaterally decided to spend $96.5mil to buy a factory that is owned by the Chairman & CEO and his family. $77.5mil of the transaction was in cash, conveniently transferring the cash out of SORL and into the coffers of the Ruili Group, a company controlled by the Chairman.

In exchange the company gained control of a factory (Development Zone Facility) and the accompanying land use rights. However, to date the certificates and documents showing SORL as the legal owner of this facility have not been transferred to SORL

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despite the fact that Ruili Group has received the majority of the cash. In effect, SORL shareholders have paid $96.5mil for a promise by the CEO and his family to honor SORL shareholder rights of ownership on the facility.

Based on a very similar situation with the Dongshan Facility, we believe it is highly likely that SORL shareholders will never technically own the Development Zone Facility. We find this an extremely disturbing development for minority SORL shareholders and highly unethical. Unfortunately, these types of risks are all too common amongst Chinese RTO's involving related party transactions.

It's important to point out that in October of last year, a group consisting of the CEO, his brother and wife proposed an offer to take the company private at $2.84 per share. The stock rallied but in January of this year they withdrew the offer. They claimed to withdraw the offer due to "market conditions." The stock quickly dropped and languished below $2 per share up until August.

At any point from January to August of this year they could have renewed the offer since "market conditions" vastly improved, but they never did. They also could have offered to buy the company at a lower price since the stock was consistently near all-time lows, still they never did. In our opinion the only likely "asset" worth acquiring would have been the cash on the balance sheet but they figured out another way to access that cash with the Development Zone Facility acquisition while essentially sacrificing nothing.

In addition, the Chairman and his family appear to be using SORL as their own personal piggy bank as they use the company's cash to guarantee loans and make actual cash deposits to secure loans to Ruili Group and associated entities. The loan guarantees and cash deposits in total are over $140mil in recent years. We find this type of behavior unethical and believe the company is able to perpetrate this type of activity specifically due to their corporate structure. It is hard to imagine a US based counterpart getting away with this type of activity without repercussions. This again highlights why SORL deserves a very low multiple.

A look inside their factory shows the equipment is old, outdated and "grimey," especially when compared to their competitors based in both China and the US. It is clear that to maintain the facilities they will need to spend millions in capex upgrades to stay competitive. Unfortunately, the vast majority of their cash is now in the coffers of Ruili Group.

SORL's previous auditor, EFP Rotenberg, was banned from auditing Chinese companies by the SEC. Their current auditor, MaloneBailey, also has had several problems involving proper audits of Chinese companies. This in combination with a string of individuals with either personal run-ins with the law, or connections to other Chinese frauds like in the

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case of PUDA Coal, ads plenty of speculation to the situation. As the old saying goes, "where there's smoke, there's fire."

It appears based on our research, that the company is dishonestly claiming that they are a "top 100 supplier" of auto parts in China. The last time we can confirm they made the top 100 list was in 2009. They appear to have not made the list since. The Chinese government has also cited the company for "severe misconduct" for forging, altering and buying/selling inspection certificates.

Over time, the company appears to be "going dark." In the early years of being a public company, Chairman and CEO Xiao Ping Zhang regularly attended quarterly conference calls. Beginning around 2013 he no longer attends the calls. The CFO also does not attend quarterly calls. The corporate website(s) are not being properly updated or maintained. The investor relations site is not updated with the latest information for shareholders. SEC files reporting a list of the executives and directors and how many shares are owned between them are inaccurate. Their auditor has admitted they have not performed an audit of the company's financial controls. If they can't provide accuracy on these basic elements, how can we trust that their financials are being accurately reported?

Our review of SORL has exposed several risks investors in the company are exposed to that we feel are not being reflected in current valuation. Ultimately, we believe Chinese RTO's are uninvestable, giving them a value of zero. In our opinion this is completely justified because as an investor in these companies, you have no shareholder control and you have no legal recourse to enforce control.

That said, we are willing to consider how investors have, rightly or wrongly, valued the company in the past to determine a price target. In our opinion, SORL deserves a valuation at the lowest end of its historical trading range, which is approximately 2x earnings. The company has guided to earnings of $14.5mil for this year or approximately 75c per share. Therefore we believe the company deserves a valuation of 2x 75c per share, or $1.50 for approximately 55% downside.

FULL DISCLOSURE: Cliffside Research and our affiliates invest in the companies we cover. We spend great effort in our due diligence process. We make investments based on our conviction in our due diligence process. You should assume at the time of publication we hold a short position in securities of the company discussed in this report. Please see our full “Terms of Service” at the bottom of this report or at cliffsideresearch.com.

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