Calling U.S.-Listed Chinese Companies To Account

The U.S. Securities and Exchange Commission has sanctioned a California firm of auditors in connection with fraudulent accounts of China Energy Savings Technology, a Chinese technology company that has been entangled with the SEC since 2006. The auditing firm, Moore Stephens Wurth Frazer & Torbet LLC along with K. Dean Yamagata, a CPA, have settled the case, as is customary in such matters, without admitting or denying the SEC’s findings of improper professional conduct. The firm is barred temporarily from accepting new auditing assignments in China and will pay $129,500. (SEC announcement.)

Bloomberg’s report notes that this is one case in what it calls a broader probe by the American regulators into Chinese companies listing in the U.S., particularly the 150 or so that have done so via a reverse merger (the acquisition of a listed shell company that then merges with its acquirer; it is a way round the requirements of making an initial public offer). A number of such companies, many small and whose operations remain overwhelmingly in China regardless of their U.S. listing, have employed small California firms to audit their books for the purposes of U.S. regulatory reporting. The suggestion is that these firms have outsourced the audit to local firms in China, beyond the remit of U.S. accounting oversight, thus leaving U.S investors at best at the mercy of shoddy accounting and at worst at risk of being defrauded.

Gadflies pushing for an SEC investigation have suggested a third of Chinese companies listed in the U.S. are reporting fictitious profits. An investigation by theStreet.com reckons the losses to American investors could run to $34 billion. Sporadic incidents of fraudulent reporting by U.S. listed Chinese companies have emerged before. Rino, a manufacturer and another Frazer client, was delisted by Nasdaq after admitting that it had reported fictitious details about contracts; Fuqi International and Sky One Medical have also acknowledged being the subject of SEC investigations.

The SEC, as its practice, won’t tip its hand to how widespread its investigation runs, or to how much cooperation, if any, it is getting from regulators in China. Going after Chinese firms’ American auditors would suggest it feels it is best off playing this on home turf.  There is nothing uniquely Chinese about penny-stock scams in U.S. markets. The question now is whether the SEC will uncover a systematic attempt to bilk U.S. investors, or whether it is just the gap between the U.S. and Chinese regulatory systems giving scope for sharp practice, reform of which will become another item to add to the long list of Sino-American trade and investment issues.

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