Fake Cash & Fake Accounting: Chinese Regulators Suddenly Halt 46 IPOs and Bond Offerings

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Wolf Richter wolfstreet.com, www.amazon.com/author/wolfrichter

The companies are clients of China’s 2nd largest audit firm, now under investigation.

On Monday, Jinhe Biotechnology and Liande Automatic Equipment disclosed in filings that they had been ordered by the China Securities Regulatory Commission (CSRC) to suspend their plans to sell bonds.

On Sunday night, four companies — Hunan Baili Engineering Sci&Tech, Jiaao Enprotech Stock, MLS Co., and Woer Heat-Shrinkable Material Co. – disclosed in filings that they had been ordered by the CSRC to suspend their IPOs in Shanghai and Shenzhen.

Regulators also stopped four IPOs on Shanghai’s Star Market, which itself debuted just last week with great fanfare. The 25 stocks listed on it gained 140% on the very first day, followed by steep declines the second day. The four companies whose IPOs got nixed, according to Yicai Global, were Beijing LongRuan Technologies, Beijing Transuniverse Space Technologies, Luoyang Jianlong Micro-Nano Materials, and Shenzhen JPT Opto-Electronics.

On Sunday, two companies disclosed that their bond offerings were stopped by regulators, according to Yicai. On Friday, seven companies disclosed that their bond offerings have been halted.

In total, regulators suspended 46 IPOs and bond offerings, based on filings made at the Shanghai and Shenzhen stock exchanges, including Shanghai’s Star Market, as of Monday, according to the South China Morning Post. The reason: these companies had chosen Ruihua Certified Public Accountants as their auditors.

Ruihua, the second largest audit firm in China, has been embroiled in scandals involving large amounts of fake data, including fake cash, on its clients’ books. The fakeness of this cash became obvious when these companies defaulted on debt that they could have easily serviced with the cash they claimed to have on their books but didn’t. And Ruihua had just signed off on those fake books.

The CSRC had finally put Ruihua under investigation on July 5 for allegedly falsifying information, according to Yicai Global, after the scandal of Kangde Xin Composite Material Group had blown up in January.

Kangde Xin had reported 15 billion yuan in available cash at the end of September 2018, but on January 15, 2019, it defaulted on just 1 billion yuan of commercial paper because that cash on the balance sheet didn’t exist.

It had been the third company in a row to default on a relatively small amount of debt despite huge cash balances on the balance sheet. “The defaults call into question the actual availability and amounts of reported cash balances,” Fitch mused at the time – a phenomenon I called “Fake Cash & Fake Accounting” in January, as China’s corporate debt was blowing up in record fashion.

CSRC then found that Kangde Xin’s controlling shareholder and former chairman, Zhong Yu, who was arrested, had embezzled funds from the company. The regulator didn’t specify if Ruihua or Bank of Beijing, the sole account manager to Kangde Xin, had helped to cover up the malfeasance, according to Yicai.

The company has also been accused of inflating profits by nearly 12 billion yuan over the past four years, “through fictitious sales, exaggerated operating costs and fictional expenses on research, development and sales,” according to Yicai.

And all under the intensely watchful eyes of its audit firm, Ruihua.

Another fake-cash company and Ruihua client, Furen Group Pharmaceutical, failed to issue cash dividends of 60 million yuan despite 1.8 billion yuan in cash on its balance sheet. When the Shanghai Stock Exchange investigated, it discovered that over 1.7 billion yuan were missing, and that the company had in fact only 3.8 million yuan in cash.

In total, 29 IPOs of companies that had Ruihua as auditor have been suspended, the CSRC said, cited by Yicai. And one of Ruihua’s clients has withdrawn its IPO application.

Investors in Chinese stocks have long been hounded by fake numbers on their financial statements. Fake cash balances are particularly pernicious in terms of audit quality because that’s one of the easier and most obvious and most important items to check out by the company’s auditor.

Fitch expects another record year for Chinese corporate defaults. And it’s during these defaults that creditors tend to discover what all is missing that they thought was there.

Nevertheless, this barrage of orders by regulators to dozens of companies – all Ruihua clients – to halt raising much needed new funds, either via stock offerings or bond offerings, is more than just another busy Monday in China’s corporate world. It shows that regulators are finally trying to crack down on pandemic accounting fraud that involves all kinds or participants, including the auditors.

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