Around this time, we found an obscure company called HQ Sustainable Maritime Industries (HQS), a company headquartered in Seattle with its primary operations in China. HQS was a vertically integrated tilapia producer and specialty healthcare product manufacturer. This time period was before the fraud prevalent in Chinese companies trading on western exchanges came to light. Unlike those frauds, however, HQS was headquartered in Seattle, had Canadian leadership, and was audited by a Canadian firm that was itself under the supervision of the SEC’s audit and accounting regulator, the Public Company Accounting Oversight Board (“PCAOB”). The PCAOB had thoroughly reviewed and approved this Canadian audit firm, giving us false comfort. We had spoken to the VP of Finance at HQS numerous times and even called the auditor to verify that they conducted appropriate audit procedures.

With the stock as cheap as it was compared to the net cash on its balance sheet and the free cash flow it was realizing, we invested up to 20% of the portfolio into HQS. The signs were there that the company’s financials might not be accurate, particularly when the company issued stock at below the current price to investment banks and private equity firms in the United States despite supposedly having a great deal of cash already and no debt. But the company provided an elaborate reason that seemed legitimate, and we swallowed it hook, line, and sinker.

The rising accounts receivable balance was another major red flag, which is what prompted us to call the auditor. Even the auditor explained away the high accounts receivable balance. We were both fooled. In April 2011, the chair of HQS’s audit committee resigned from the Board of Directors and issued a press release accusing management of fraud. It took another two months for the Canadian auditor to finally throw in the towel and admit they too were fooled. We did not wait for the auditor to quit before writing off the entire investment in HQS. The information provided by the former Audit Committee Chair was too damning for us to ignore. We wrote off the investment the next day, immediately taking a roughly 20% hit to our portfolio.

We did not hide from the HQS disaster. We sent an e-mail to our investors the very next day explaining everything. Not one investor asked for his or her money back. Our investors still believed in us. We like to think we have rewarded that belief.