China accounting scandal threatens corporate fundraising

Fundraising disrupted as listings halted in situation evoking Arthur Andersen collapse

An accounting scandal rocking corporate China is drawing comparisons with the collapse of US firm Arthur Andersen as dozens of Chinese companies are forced to halt public listing work.

Ruihua Certified Public Accountants, one of China’s largest accounting firms, was investigated by the country’s securities regulator early this month after a listed company it audited was found to have inflated profits by about Rmb12bn ($1.74bn) over four years.

The probe has caused an unprecedented disruption in fundraising activities for Chinese companies, with more than 50 Ruihua clients halting initial public offerings and private capital raising, according to state media.

The China Securities Regulatory Commission has suspended IPO approvals for at least 20 Ruihua clients. Several listings on China’s new Star Market board have also been delayed.

Ruihua did not respond to emailed queries.

China is trying to clean up its stock market and they are finding big problems with the way that auditing is being done. Paul Gillis, Peking University

The situation, which Chinese media have dubbed the “Ruihua incident”, is evoking the collapse of US accounting firm Arthur Andersen, one of the largest in the world until the 2001 bankruptcy of energy group Enron led to its dissolution.

“This reminds me of when Arthur Andersen went out of business because it’s the same kind of crisis of confidence with everyone bailing out,” said Paul Gillis, an accounting specialist and a professor of practice at Peking University’s Guanghua School of Management.

Prof Gillis noted that the probe into Ruihua comes as regulators are attempting to attract more foreign investment into the domestic stock market. “China is trying to clean up its stock market and they are finding big problems with the way that auditing is being done,” he said.

A string of auditing scandals this year have shaken investor confidence in Chinese equities at a time when global investors are increasing their allocation to the Chinese market through the MSCI emerging markets index.

Chinese drugmaker Kangmei Pharmaceutical admitted in May to overstating cash holdings by more than $4bn.

The manufacturer of traditional Chinese medicines, which is being probed by the country’s securities regulator over suspected disclosure violations, was one of more than 200 Chinese companies included in MSCI’s flagship emerging markets index, a benchmark tracked by global investors managing about $1.9tn.

In a statement, MSCI said it has “since removed Kangmei from the index, although it was still listed as a constituent on Wednesday.

” MSCI recently increased the weighting for Chinese stocks in its EM index, a move that is expected to lead to an inflow of more than $100bn as investors are obliged to allocate more to China. But critics have said the increase has also increased investors’ exposure to many of the accounting irregularities on the Chinese stock market.

Ruihua client Kangde Xin Composite Material said earlier this year that it was missing bank deposits of more than Rmb12bn. The probe that followed revealed that the company had inflated profits by about the same amount for several years, leading to the July investigation into Ruihua.

“For years I have commented that financial records can never be truly relied upon in any emerging economy, including China,” said Stuart Witchell, the Asia-Pacific head of business advisory group Berkeley Research. “Accounting documentation can be easily massaged, and with so much money at stake the temptation to do so will remain, especially during times of economic uncertainty.”

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