Postings | China Accounting Blog | Paul Gillis


Son of Enron

I have recently published two articles on how the accounting standard developed to prevent another Enron was perverted to create Chinese variable interest entities. Accounting standard setters ought to take a hard look at how this standard is being applied.

The first article, for a general audience, is in Foreign Affairs.  The second, more academically oriented, is in the Journal of Applied Corporate Finance

I remain hopeful that China will, as promised, revise the rules on foreign investment in e-commerce and education and make the VIE structure obsolete. 

NQ Mobile still at Level 2

NQ Mobile (NYSE:NQ) filed its annual report on Form 20F on Monday, nearly 6 months late. NQ was the subject of a Muddy Waters report on October 24, 2013 that sent the stock price tumbling. A board initiated special investigation found no evidence of fraud, but reported that certain information had been erased from electronic devices. Auditor PwC demanded that it be allowed to expand the scope of its work, and NQ fired PwC and replaced them with Marcum, Bernstein and Pinchuk (MBP) a U.S. based auditor that specializes in smaller U.S. listed Chinese companies. MBP was ultimately able to complete the audit and issue the report.

PwC refused to consent to the use of its prior reports on 2011 and 2012, so MBP had to reaudit those years. Curiously, PwC did not withdraw its opinions on those years – it simply refused to consent to their use in the current filing. 

One of the issues Muddy Waters raised in their initial report related to the classification of bank deposits as Level 2 assets in the financial statements. Muddy Waters suggested that meant the cash balances were highly likely to not be real. I disagreed with Carson Block on that matter, and got into a twitter fight with him and the lovable and reformed convicted felon Sam Antar of Crazy Eddie fame. In my view, Level 2 is just a description of how the asset is valued, and while practice varies, I believe that Level 2 is the right description for these assets. I was amused to see that all of the bank deposits are still classified as Level 2. I guess that is a fitting ending to my coverage of the NQ saga. 

Understanding Chinese cash flow statements

A short selling research group called Anonymous Analytics (AA) published a short report on Hong Kong listed Tianhe Chemicals Group Ltd (1619:HK) on September 2. Tianhe, listed only this past June, was the seventh company at-tacked by AA. While the people behind AA are not identified, I am told by a re-liable source that I know all of them, which suggests they are prominent shorts operating under a pen name. There is the usual menagerie of allegations, and AA published a letter to Tianhe’s auditor Deloitte pointing out some matters Deloitte should be looking into, a technique first used in Muddy Water’s attack on China Media Express in 2011. Deloitte has said nothing publicly, and they won’t unless they either prove the fraud or find that management has lied to them, in which case they will resign. 

Tianhe asked the Hong Kong Stock Exchange to immediately suspend trading. That can be a smart strategy since it prevents the shorts from covering while they continue to pay for borrowed stock. Trading resumed a month later after the company responded to the 20 page AA allegations with a 55 page response alleging that AA had fabricated documents, forged signatures, and hacked email. Shares dropped 40% on resumed trading. The company and AA have since trad-ed insults but the stock remains down 54% from its high, suggesting investors believe AA over management. 

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