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MOF on selecting accounting firms

The Ministry of Finance has issued a notice recommending that large and medium-sized companies in China should select accounting firms that have been authorized by the State to audit H-share companies.  The rules are intended to implement Document 56 of the State Council, which set forth government policy for the accounting profession.  

There are 12 accounting firms in China that have been approved to audit H-share companies.  The list includes all of the Big Four firms in China.   The effect of the notice is to encourage further concentration of China’s accounting profession at the expense of small local accounting firms.   Many of China’s medium-sized firms have selected local auditors, many of which are not on the list of H-share auditors.  While some large local accounting firms have emerged in recent years (mostly affiliated with second-tier global alliances like BDO, RSM, and Crowe Horwath), none have really established a national network capable of serving companies in all of China’s important cities.   This policy may help the larger firms build a true national network.

Understanding Chinese frauds

Last month I wrote a post where I pointed out two cash confirmation plays – situations where I thought that the allegations of fraud would be disproven if the auditor was able to successfully confirm the recorded cash balances using the extended procedures that most firms are using today.  Both situations have now failed. Longtop Financial Technologies failed first when Deloitte resigned after a series of incidents that are dramatic enough for a screenplay

Yesterday China-Biotics failed its cash confirmation test when auditor BDO resigned. China-Biotics is alleged by BDO to have put a new spin on cash confirmation issues.  Rather than get the complicity of the bank, China-Biotics is alleged to have set up a fake bank website. From BDO’s entertaining resignation letter, it appears that China-Biotics was tripped up when it gave BDO a fake bank statement on which it had miscalculated interest income. BDO must have known they were on to something when the client then produced a “corrected” version.  NASDAQ has already commenced delisting procedures

SEC to deregister two bank confirmation scams

The SEC announced on Monday, June 13, 2011, that it has instituted proceedings to determine whether stop orders should be issued suspending the effectiveness of registration statements filed by two companies – China Intelligent Lighting and Electronics Inc. (CIL) and China Century Dragon Media (CDM).  Both of these companies were recently involved in bank confirmation scandals.

The proceedings, which will commence on June 24, will likely lead to the revocation of the companies registration statement. While AMEX had already suspended the companies from trading, this action will end their status as public companies in the U.S. Many of the Chinese companies alleged to have committed fraud have been delisted from the major exchanges, but many, like early case RINO, continue to trade on the pink sheets.

It is encouraging to see the SEC move so quickly against these companies. Conspicuously missing, however, is a report by Chinese authorities that they have arrested company and bank officials for fraud.  The company executives and bank officials are probably sleeping better after China suspended the death penalty last month.

Stealing the VIE

I want to call the attention of our readers to two great blogposts related to Gigamedia that will be of great interest to those following the VIE story. It appears that Gigamedia decided to demote the head of their China operations, but perhaps the board should have first considered that he owned their VIE. He is gone, the VIE and all the chops are gone, and the company is in a world of hurt. 

The first post was written by my former student Fredrik Oqvist, who also blogs here occasionally but has now started an excellent blog called China Finance.  

Stan Abrams, a Beijing based lawyer and professor, blogs at China Hearsay.  Stan picks up on Fredrik's post. I have nothing to add to these posts - they are consistent with everything we have been writing on this blog. 

Speaking of blogs, there is an excellent post on reverse mergers at the China Law Blog. The post also says nice things about this blog! The China Law Blog was the inspiration for this blog and we have found that the interests of the accounting and law professions often overlap.  

PCAOB rejects HK CPA firm

On June 9, 2009, the Public Company Accounting Oversight Board (PCAOB) rejected the application for registration by Zhonglei (HK) C.P.A. Limited (Zhonglei HK).  Zhonglei HK had applied for registration on November 10, 2010.  On October 7, 2010, the PCAOB announced that it would no longer register firms based in jurisdictions where the PCAOB was restricted from performing examinations.   Following its policies, the PCAOB asked Zhonglei HK to state its understanding of whether a PCAOB inspection of Zhonglei would currently be allowed by law or authorities in Hong Kong, including Chinese Mainland authorities to the extent that the examination relates to work performed for issuers with mainland operations.  Zhonglei HK responded that a PCAOB inspection would currently not be allowed by local law or local authorities.  China has taken the position that PCAOB inspections would violate its national sovereignty.

Zhonglei HK was given the option to put its application in pending status without board action until such inspections would be allowed.  The PCAOB has indicated it hopes to reach agreement on inspections this year.  Zhonglei HK, however, rejected that option and asked the board to take action on the application and this action was the rejection.  Perhaps Zhonglei HK was advised by mainland officials to seek the rejection – possibly to set up a confrontation over this issue. The company, however, indicates that it simply gave up.

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