Banking & Finance

Under audit

Ruihua accounting scandal postpones 60 IPOs


Huishan Dairy: collateralised cows

“If any problem is discovered in the accounts books, then the person in charge of administration and accounting and other officials should be liable for the indemnification against the insufficiency.”

Such was the accounting stipulation 2,000 years ago, when China was first unified under the Qin Dynasty. The word auditor is said to derive from the Latin ‘to hear’ (officials had the accounts read out to them) but the oldest examples of the practice derive from Shang Dynasty tortoise shells from nearly four thousand years ago: these recorded tributes to the emperor on the right hand side of the shell and verification of their existence on the left.

Since then, accounting standards have had a habit of falling by the wayside. Modern China is littered with cases – just ask investors in Sino-Forest, a company that didn’t own a single tree, or in Hong Kong-listed Huishan Dairy, which wasn’t producing the feed that it claimed for its cows (and which were tapped more as collateral for loans than for their milk). And how about the seafood operators whose scallops “ran away,” taking their companies’ profits with them (see WiC260)?

As we reported in WiC461, the China Securities Regulatory Commission (CSRC) is investigating another four companies as part of a crackdown against miscreants and their auditors. It has also turned the spotlight on the second largest domestic auditor Ruihua, following the arrest of the chairman of one of its clients, Kangde Xi Composite Materials, for embezzling funds.

International investors are getting more focused on financial transparency because changes to the MSCI index are forcing them to quadruple their weightings of large cap A-shares this year. But Guanghua School of Management’s Paul Gillis told Southern Weekend that China does not have the same deterrents to malpractice as the US, where company executives are subject to criminal charges, as well as lawsuits from aggrieved investors.

The newspaper concluded that “auditors are facing a crisis of national trust as gatekeepers to the capital markets”, noting that 60 domestic firms have had IPOs or capital raises put on hold because of the investigation into Ruihua. Huang Shizhong, dean of the Xiamen National Accountancy Institute, argues that the “frequency of fraud is directly related to the amount of M&A that Chinese accountancy firms have pursued over the past decade.” To compete with the Big Four of PwC, Deloitte, EY and KPMG, domestic accounting firms have followed an M&A strategy of ‘bigger is better’. But as Southern Weekend points out, the local auditors’ acquisitions have faced integration issues, leaving management teams freer to operate beyond centralised controls.

A similar situation brought down Arthur Andersen, which famously imploded after the firm’s accountants in Houston put billings from their client Enron ahead of their fiduciary duties. This and other scandals around the turn of the century led to the Sarbanes-Oxley Act and the creation of a Public Company Accounting Oversight Board (PCAOB).

However, that body’s inability to supervise the China-based auditors of US-listed Chinese companies (Beijing objects to the oversight on “national security grounds”) is a growing bone of contention, and something that US Senator Mario Rubio plans to remedy with legislation that ultimately threatens to delist such firms from American bourses.

In a Wall Street Journal post entitled “You Can’t Trust a Chinese Audit,” Rubio said 156 Chinese companies, including 11 state enterprises, are listed on America’s three largest exchanges, with a combined market value of $1.2 trillion.“Beijing’s intransigence ensures that American investors don’t get a true picture of those companies’ financial health,” he warned.

Back in China the CSRC promises stiffer punishments for malpractice (corporate fines currently extend to just Rmb600,000), while Guanghua’s Gillis wonders whether “Ruihua will be with us for much longer”. At the very least it will slip down the rankings, as did ShineWing, the largest domestic accountant until it was fined for an audit failure in 2017. The only other purely domestic firm left in the top 10 is Pan China, according to figures from the Chinese Institute of CPA.

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