Another VIE collapse | China Accounting Blog | Paul Gillis

Another VIE collapse

Another VIE arrangement appears to be collapsing. Nutrastar International Inc. (OTC BB: NUIN) (Nutrastar) was listed in the US through a reverse merger. Nutrastar’s primary product is cordyceps militaris, a species of parasitic fungus used in traditional Chinese medicine. 

Nutrastar reports $139 million of cash and only $5 million of debt, yet has a market capitalization of only $6 million.  We have learned that sometimes Chinese companies do not have the cash they report, and auditors have often been duped on this.  In this case, the problem seems to be that the public company, incorporated in the US, cannot access the cash (even if it exists) because it is in a VIE.

Nutrastar’s financial statements omit required disclosures of the assets of the VIE. The SEC should require the company to provide these disclosures and discipline the auditor for not requiring them.  Nevertheless, we can tell from the separate financial statements of the parent that the cash is likely in the VIE, and in RMB, not US dollars. 

On February 5, 2016 Nutrastar’s CFO quit. His resignation letter says he quit because the company’s CEO, Han Lianyun, had refused to allow access to assets in China in order to pay obligations of the parent company. The company disclosed that it could not access the cash in China without consent of Ms Han, and she was no longer communicating with the board. An audit committee member quit three days later citing the same concerns. 

Nutrastar has three VIEs, Heilongjiang Shuaiyi, Daqing Shuaiyi and Harbin Shuaiyi, Ms. Han is the controlling shareholder of Heilongjiang Shuaiyi, and the other two VIEs are subsidiaries of Heilongjiang Shuaiyi. The company disclosed in its Form 10K for the year ended  December 31, 2014 that: “There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including, but not limited to, the laws and regulations governing our business, or the enforcement and performance of the Contractual Arrangements with the VIE Entities.”   That is a boilerplate disclosure on Chinese companies, but this case shows that investors should actually heed those disclosures. 

So, what appears to have happened is that the company put all its cash into the VIE and now it cannot get it back. This is alleged to be because of Ms. Han's uncooperative stance, but I question whether there is a legal way to get this cash out of the VIE and into foreign currency. I have questions about how the cash got into the VIE in the first place, since this is very difficult to do under China’s exchange controls.  

To add insult to injury, it is not clear to me that the company even needed to use a VIE, since I don’t think this industry is restricted for foreign investors. That should also have been a red flag for investors. It would have been much easier for shareholders to get access to the company’s cash had it been in a wholly owned subsidiary. 

Given the market cap of the company is only 4% of its reported cash balances, it appears shareholders have figured out they are never going to get access to the cash (assuming it actually exists). I predict the shareholders will be wiped out. 

Nutrastar illustrates the several of the problems that the VIE structure creates. Getting foreign currency into and out of a VIE is very difficult under China’s exchange rules, and has become much tougher with China’s recent crackdown on foreign exchange transactions. The VIE structure creates a moral hazard where the owner of the VIE can potentially profit by simply refusing to acknowledge the VIE agreements, and Chinese courts and arbiters have been reticent to enforce VIE agreements against Chinese CEOs.

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