You may not have heard of the SEC’s Cross-Border Working Group but if you are a company with substantial foreign operations that trades in the United States, chances are the Working Group has heard of you. Since it began, the Working Group has led to the filing of fraud cases against more than 65 foreign issuers or executives and deregistering the securities of more than 50 companies. The Working Group has recently focused on Chinese companies.
The China MediaExpress Complaint
The most recent case involves a Chinese company called China MediaExpress. According to the SEC’s complaint, the company “purports to operate a television advertising network on inter-city and airport express buses in the People’s Republic of China.” The SEC filed the complaint against not only MediaExpress but also its CEO Zheng Cheng.
The SEC alleges that, in filings signed by Mr. Cheng, the company
massively overstated its cash balances in filings with the Commission and press releases issued to the investing public.
How big was the supposed fraud? Pretty darn big.
Specifically, the complaint alleges that the company reported increases in its business operations, financial condition and profits after it became a public company. This was no minor overstatement of cash balances; it allegedly ranged from 452% to over 40,000% of actual cash balances. For example, in its 2009 10-K, the company claimed to have $57 million in cash on hand; according to the SEC, it had only $141,000. “Brazen” doesn’t really begin to cover that alleged level of overstatement.
The complaint also alleged that the company stated in press releases that it had two major multi-national companies—Pepsi and Apple—as advertising clients when they were not actually clients.
Unusual for a CEO, Mr. Cheng allegedly had a hands-on role in the fraud. The complaint contends that he had a personal financial incentive to hit certain income goals because he would receive large amounts of stock if the goals were met. For example, he allegedly received stock worth $6 million based on the company’s falsified financial statements.
The Story Unfolds
The SEC claims that the ChinaExpress’ (unnamed) external auditor raised serious concerns about the financial statements:
[I]t had suspicions concerning fraudulent bank confirmations and statements, invalid tax invoices and falsified confirmations of accounts receivables and payables.
The external auditor resigned.
That’s probably when the SEC started investigating. Nothing like the resignation of your public auditor to pique the SEC’s interest.
The company responded in a typical fashion. According to the complaint, MediaExpress hired a large law firm to conduct an internal investigation into the auditor’s accusations. The law firm in turn hired a Hong Kong-based forensic accounting firm to help it, because we all know lawyers can’t actually understand financial statements. The accounting firm wanted the company’s bank records to check the reported numbers.
And that’s where the real fun begins.
Mr. Cheng supposedly called one of the accountants working on the internal investigation and demanded that they meet in a hotel café. Alone, of course. The SEC complaint alleges that
Cheng then offered the senior accountant a bribe of RMBIO million (approximately $1.5 million) to “assist with the investigation.”
Mr. Cheng was allegedly concerned that when the accounting firm saw the requested bank records, the house of cards would collapse. The accountant refused the bribe and reported it to his firm. When Mr. Cheng refused to step down as Chairman, the forensic accounting firm resigned.
For those of you keeping score:
Forensic accounting company
The law firm continued its investigation and eventually obtained the banking records. Those banking records supposedly prove the falsity of the financial statements.
In a statement of the obvious, the SEC’s complaint concluded with a section containing allegations that “China Media lacked adequate recordkeeping and internal controls.”
The SEC charged Mr. Cheng with false certification of public filings under Rule 13a-4 and false statements to external auditors under Rule 13b2-2. He was also charged with aiding and abetting the company’s recordkeeping violations.
The SEC is clearly focusing on foreign-based corporations and has also targeted Chinese companies in particular. It’s not hard to see why ChinaExpress was charged with violating the securities laws, but if the Working Group continues to go after Chinese companies it raises the specter that there are political forces at work here, too. Given Mr. Cheng’s alleged conduct, though, it’s hard to see how the SEC will not end up with a favorable settlement.