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Auditors on Alert Over Chinese Results

Robert Cookson in Hong Kong
Sunday, 25 Mar 2012 | 10:33 PM ET

A new wave of scandals involving Chinese companies listed overseas could hit New York and Hong Kong in the coming weeks as the annual results season get under way with auditors on high alert for fraud.

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Auditors are under great pressure this year to detect discrepancies in their clients’ results, having faced embarrassment and legal action in 2011 following dozens of accounting scandals at Chinese companies listed in North America.

In the last fortnight, Deloitte has resigned as auditor of two Hong Kong-listed Chinese companies: Boshiwa International , a maker of children’s wear, and Daqing Dairy Holdings , which produces milk formula.

Hundreds of Chinese companies listed in Hong Kong are preparing to file their financial results for the year ended December 2011 in the coming days ahead of a deadline on March 31. For those listed in New York, annual reports on Form 20-F are due by April 30, two months earlier than last year.

“Buckle your seat belts, it’s about to get bumpy,” said Brian Fox, founder of Confirmation.com, the web-based audit confirmation group, who expects to see more auditor resignations at Hong Kong-listed companies this year.

Auditor resignations are extremely rare and are seen as a red flag by investors. Boshiwa’s shares tumbled 36 per cent on March 14 before being suspended from trading, after Deloitte resigned.

In its resignation letter, Deloitte said it had “concerns about matters pervasive to the financial statements”, including the “existence” and “commercial substance” of transactions with certain suppliers. Boshiwa said it was “disappointed” with Deloitte’s decision to resign and would appoint a new auditor in due course.

Paul Gillis, a professor of accounting at Peking University, said auditors have “upped their game” this year. In particular, he said, “auditors have significantly improved their processes for confirming the cash balances”, which were part of the majority of Chinese accounting problems that have been disclosed.

Last year, Deloitte quit as auditor of Longtop after accusing the company of “very serious defects”, including faking its bank statements. As has happened in many cases after auditors resignations, Longtop delisted from the New York Stock Exchange last August.

To guard against the risk of counterfeit documents, most auditors have over the past year stopped accepting bank confirmations in the post, Mr Gillis said.

“Most auditors now go to the bank and physically pick up the confirmation themselves,” he said. “They typically make sure that there’s several people at the bank who are involved in the process so you can’t have just one corrupt officer.”

Daqing Dairy could not be reached for comment. Trading in the company’s shares was suspended on Thursday ”pending the release of an announcement in relation to the resignation of the auditors which is price sensitive in nature”.

The Bloomberg China Reverse Merger index, which tracks 82 small Chinese companies that joined US bourses via a process called a reverse merger, has tumbled 67 per cent since its peak at the start of 2010. The index is trading on a price-to-earnings ratio of just 4.6, compared to a ratio of 14.4 for the S&P 500.

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