Jiangbo Pharmaceuticals (NASDAQ:JGBO) was advised by NASDAQ on August 1 of plans to permanently delist the company's stock. This followed a tumultuous year for Jiangbo, with the CFO resigning in March, the infamous auditor Frazer Frost declining to stand for reappointment (that must have stung), followed by the audit committee resigning en mass in June.
It would be just another fraud story but for the amazing 23 page letter written by Michael Marks, the chairman of the audit committee. Marks is a former PwC auditor from South Africa. The letter explains in great detail the process the company went through to investigate the fraud allegations. Caldwalader and Ernst & Young were engaged, but faced considerable obstacles put up by management. Ultimately, the investigation was terminated and the audit committee resigned. It is a tale that anyone interested in the endgame in China fraud will want to read.
I have written quite a bit about the epidemic of frauds in Chinese stocks. Few frauds allegations against Chinese companies have been proven to date, although many companies have been delisted after their auditors have resigned. A good starting point for keeping score on fraud allegations is the number of class action lawsuits filed against U.S. listed Chinese companies. The class action bar seems to have a hair trigger for filing these suits, but they do represent allegations of wrongdoing. Many are unlikely to be proven or the suits may be dropped if the odds of settlement become too low.
According to a report by Advisen, five class action lawsuits were filed against Chinese companies in 2009. The number increased to 23 in 2010 and to 44 in the first half of 2011.
It will take years for these lawsuits to be sorted out, if they ever are sorted out. There are many obstacles to shareholders recovering from these companies. The assets and the officers are usually in China, and even if the shareholders are successful in obtaining a judgment, they may be unable to enforce it.
On July 31, 2011 the National Association of State Boards of Accountancy (NASBA) in the United States approved a proposed mutual recognition agreement (MRA) with the Hong Kong Institute of CPAs. The agreement is subject to further approval by the AICPA Council and is expected to be signed at the NASBA annual meeting in October. Because CPA licensing is done by each of the states, the AICPA does not serve the same role as the HKICPA and many other overseas accounting associations. NASBA coordinates the efforts of the state boards to provide consistency in the U.S. for accounting regulation.
MRAs allow CPAs to obtain licensing in another country without having to go through the entire examination process again. Hong Kong currently has MRA’s with 11 overseas bodies, all of which are in the British Commonwealth. Hong Kong also has an agreement with China to exempt Chinese and Hong Kong CPAs from certain examination papers. Hong Kong previously had an MRA with the United States, but it was terminated in 2005 and the negotiations for a new one have been going on since.
This blog was among the first to explore the Chinese phenomenon of the variable interest entity. Explaining VIE Structures is the most viewed page on this site, with over 9,000 hits. It has been cited in numerous other publications that seek to explain the risks of the VIE structure. As regular readers may have observed, I have moved away from covering every development regarding VIEs because there are other China accounting issues that fit better with the purpose of this blog. My former student Fredrik Öqvist is blogging on VIEs, and I recommend his blog for the latest developments.
That said, Rocky Lee of Cadwalder, Wickersham and Taft has published an excellent ten page summary of VIEs on the firm's website. His conclusion, that the VIE structure remains valid when structured and used properly, is perhaps a bit self-serving. He does, however, acknowledge the considerable uncertainty present.
Indirectly citing this site, Lee points out that 42% of U.S. listed Chinese companies use the VIE structure. Interestingly, he also asserts that thousands of unlisted companies continue to operate through the use of the VIE structure. Private deals structured through VIE agreements probably rely more heavily on trust than the enforceability of legal agreements, but this does point out that VIE risks may be more pervasive than just the China concept stocks.