In the wake of Caterpillar’s $580 million write-down of the value of a Chinese acquisition where it claimed to have discovered major accounting irregularities, Beijing-based accounting expert Paul Gillis has helpfully detailed several methods crooked Chinese companies commonly use to cook the books.
The tricks Gillis mentioned include faking sales and then fabricating cash that should have flowed in from those sales by, for example, pretending money is temporarily being held by subcontractors the company has hired to carry out some business on its behalf.
What unites the alleged fraud at Caterpillar’s Chinese subsidiary, Siwei, with the methods described by Gillis are their simplicity. While Enron hid its losses by conducting derivatives transactions with its own off-balance sheet vehicles and Bernard Madoff went to extreme lengths to conceal his Ponzi scheme with a purported “split-strike” trading strategy, corrupt Chinese companies often inflate sales by fabricating deals and inventing false customers.
According to Caterpillar, Siwei turned out not to have much of the equipment it had listed on its books.
In his interview with China Money Podcast, Gillis wondered aloud why Caterpillar’s auditors did not notice Siwei’s missing equipment before the acquisition. “Did the accounting firms miss what was right in their face?” he mused.
Rod Sutton, an insolvency expert and the Asia Pacific chairman of professional services firm FTI Consulting, says he is often baffled by how auditors miss what turn out to be uncomplicated financial irregularities at Chinese companies. ”Often, what we deal with are basic cases of inflating revenues that really do not have an Enron level of complexity.”
Here are some of the most colorful, and simple, Chinese accounting scandals that have hurt overseas investors in the past. Alleged frauds at Chinese companies listed on American stock exchanges have recently created a furore. But in fact, many really astonishing accounting humdingers have occurred at firms listed in Hong Kong, where investors tend to be more reserved and less likely to moan about their losses in the media than their New York counterparts.
China Public Procurement, which announced a huge contract with a non-existent customer. This Hong Kong-listed Chinese IT company claimed in February 2010 to have won a 300 billion yuan ($48.1 billion) contract (pdf) to supply a purported subsidiary of Chinese government-backed rail firm China Railway Construction Materials Group named “Hua Tie”. A few months later, the Chinese newspaper the Economic Observer questioned the authenticity (paywall) of the contract. Under pressure from the Hong Kong stock exchange, CPP’s board appointed forensic accountants from PwC, who confirmed last November that “Hua Tie” appeared not to exist. So far, Hong Kong’s securities regulator has not announced any investigation into the company.
Hontex International: fake sales and fake cash in the bank. This Taiwanese-owned Chinese fabric maker was forced to freeze the proceeds of its December 2009 Hong Kong IPO after its auditor, KPMG, realized almost six months after the listing that there were “discrepancies” in its IPO prospectus. KPMG had taken a second look at the prospectus after discovering Hontex employees offered bribes to some of its auditors. Last June, Hontex admitted in court it had inflated its sales figures and cash balances for the years leading up to its listing. Hong Kong’s Court of First Instance has ordered the fabric maker to return the HK$1.03 billion ($133 million) it raised in its IPO to investors.
Real Gold Mining: “Whoops, our biggest shareholder pledged the listed company’s assets to a bank.” Real Gold is a Hong Kong-listed Chinese miner. The city’s securities regulator began investigating it in August 2011. In June of that year, Real Gold had confirmed this report (paywall) in the South China Morning Post that its founder, Wu Ruilin, had pledged the listed company’s Chinese assets as security for loans for private companies he controlled. This meant that the lender, Shanghai Pudong Bank, may have been able to seize Real Gold assets—which its shareholders thought they owned—if Wu’s other businesses had run into financial trouble. Details of the pledge were already in the public domain, having been filed with China’s company registration department, the State Administration for Industry and Commerce. But Real Gold’s auditors, Deloitte, who resigned a few months after the scandal, had not noticed.
Moulin Global Eyecare, where a big customer turned out to be a Chinese restaurant in Nebraska. Back in 2005, Hong Kong-listed eyeglass maker Moulin Global Eyecare, which operated factories in mainland China, claimed to be one of the world’s largest companies of its type, with a business empire spanning Asia and Europe. It went bust in 2006. Moulin was a prime example of how companies that fake their revenues get tied up in knots when they are unable to show auditors the cash that would have flowed in had the sales been real. To play for time, the company’s liquidators Ferrier Hodgson said, Moulin created a series of phantom companies (paywall) in the eyeglass business that allegedly owed it money. One of these alleged customers later turned out (paywall) to share an address and telephone number with the “Goodlife” Chinese restaurant in Nebraska. (There was never any suggestion the restaurant was connected with Moulin or implicated in the case.) Moulin chairman Ma Bo-kee and his son, Cary Ma Kit-lin, were imprisoned for 12 and 10 years respectively in 2010 for offenses including inflating sales and misleading auditors.