NQ's Auditor - Printable Version

I stumbled accross this article on Seeking Alpha from 2012. Interesting read. Can we confirm Zhong Tian is still NQ's auditor?

"I don't invest in Chinese companies" is a statement made by many professional and retail investors.

In the past couple years, there has been widespread fraud among Chinese companies traded on U.S. exchanges. Investors have also done well these past couple of years shorting Chinese scams. Many of these fraudulent companies had a Big Four auditor sign off on their annual reports claiming the financial numbers were correct.

When buying or shorting a Chinese stock, it's important to look at the Chinese auditor and how reliable it has been in the past. The auditor that I've found to have an unblemished record is PriceWaterhouseCoopers Zhong Tian. It has so far never signed off on a financial report that contained fraudulent numbers. (Note: This is just a study on this particular branch of PWC, and doesn't include other branches like PWC Hong Kong for example.)

The following is a list of primarily fraudulent Chinese companies that have been halted last year which also includes their auditor. This is borrowed from TheForensicFactor's Seeking Alpha Instablog titled: Dear PwC - Do AutoChina's financials pass the smell test?

From this list, many auditors' names appear over and over again - Deloitte & Touche and Malone Bailey, for example. I wouldn't trust a Chinese company's financials with either one of them as the auditor. PWC Zhong Tian only comes up once on the list for Wonder Auto Tech (WATG.PK). Since trading was halted on Wonder Auto on May 6, 2011, it has since been exposed as engaging in several related party transactions without disclosing them. Nasdaq later booted the company off its exchange to the pink sheets.

Wonder Auto appointed PWC Zhong Tian as its independent auditor in December, 2010. However, Zhong Tian has never signed off on an annual report for the company. Wonder Auto reported on December, 2011 that Zhong Tian resigned as their independent auditor.

A similar situation happened with Autochina (AUTCF.OB). As explained in this article, Autochina had disagreements with the SEC about accounting procedures and moved off the Nasdaq and onto the OTC BB exchange. The company then dumped PWC Zhong Tian for another auditor before it had ever signed off on an annual report. The reason, quoted from the above linked article, is:

Taken from the Public Company Accounting Oversight Board (PCAOB) the following are Chinese companies trading on U.S. exchanges that have PWC Zhong Tian as their independent auditor for the last two annual reports:

Companies that PWC Zhong Tian had signed off on at least one annual report but aren't listed above are Ambow Education Holding (AMBO) and China Automotive Systems (CAAS).

If you are short one of the above firms because you think the company won't do well and the stock is overvalued, then that's OK. However, based on the reputation of the auditor, if you're short because you think the numbers on the annual reports are false, then I would advise covering your short position.

Likewise, if you are looking for a legitimate Chinese company to invest in, you should be safe with one of the above. However just because they are all audited by Zhong Tian it doesn't mean the stock will go up or that it's a good company, it only means that the financial numbers are most likely accurate.

An auditor's job is to make sure that the financial numbers are correct, period. This includes not only making sure the math is done right by the company's internal auditors, but also to check the numbers are from third party sources to make sure they aren't fabricated by the company. An example is checking with the company bank's main headquarters to verify the balance instead of a local bank that could be in on the scam. Evidence has shown that Zhong Tian has a lengthy and thorough auditing process. On the flipside, auditors are not financial analysts. It isn't their job to figure out if management is doing a good job running the company, or if the management will make good decisions in the future.

One example of a company that Zhong Tian audited and is now biting the short sellers, is China Medical Technologies.

PWC Zhong Tian has signed off on its past three annual reports. I wrote about the company and its management's strange behavior here. Because of management's "going dark" and cutting off communication with its shareholders, I questioned whether its balance sheet and large cash balance is real.

However, the stock is currently on a tear - from a low of $0.62 after it got demoted to the pink sheets on February 29, to over $3.00 as I write this. Those that shorted the stock at around $2.00 before it got delisted from the Nasdaq and held on hoping the stock will reach zero are in a tough position right now. There's more than just dumb money pushing that stock up. Management has no doubt gone crazy, but the cash might really be there. Add to that an auditor that has so far never made a mistake, and it's possible this is a stock that will keep going up.

Here is another surprising article, although it has to be stressed that NQ isn't a reverse merger

Chinese reverse mergers are not toxic: Study

In fact, they have performed as well as or better than comparable companies trading in the United States.

"We find virtually no evidence that Chinese RMs are systematically more problematic than other comparable firms that are already listed on the same exchange," the professors say in the study, titled "Shell Games: Are Chinese reverse merger firms inherently toxic?"

The study was authored by Charles M.C. Lee of Stanford University, Kevin K. Li at the University of Toronto and Ran Zhang of Peking University.

It examined the financial health and performance of reverse mergers that came to the U.S. market between 2001 and 2010. China-based companies represented 85 percent of foreign reverse mergers.

A reverse merger was once a popular way for private firms, especially foreign-based, to gain a listing on the U.S. exchanges by merging with a public company while bypassing a more costly and rigorous initial public offering process.

In recent years, the practice came under severe regulatory scrutiny after a slew of firms, primarily China-based, were involved in accounting scandals and saw their trading suspended or halted.

Those include China MediaExpress, Rino International and China Agritech, which once traded on Nasdaq, as well as Heli Electronics.

A rare ruling came in July, when the Securities and Exchange Commission overruled an earlier Nasdaq decision to delist Clean Tech, a China-based reverse merger company that designs and manufactures steel towers for wind turbines.

However, the study found that Chinese reverse mergers outperformed their peers from inception through 2011, even after including most of the firms accused of accounting fraud.

"Despite the negative publicity (some from short sellers), we find little evidence that U.S. capital markets have been harmed by the admission of CRMs," the study authors wrote.

According to the study, while reverse merger companies are speculative in nature and are prone to bankruptcy, Chinese firms tend to be more mature and less speculative than their U.S. peers.

"They are larger, less levered, more profitable, less likely to have a qualified audit opinion, and more likely to be at the Growth or Mature stage of the business life cycle," the study said.

China is fundamentally undervalued: Macquarie

Sam Le Cornu, senior portfolio manager of Asia listed equities at Macquarie, talks about why he likes consumer discretionary stocks in China.

Chinese reverse mergers also outperform U.S. peers in profitability, cash flows, likelihood of receiving a qualified audit opinion, survival rate and changes in market liquidity, according to the study.

"The current Sino-phobic reaction to Chinese reverse mergers may be overblown," the authors concluded. "Our results do not support the view that CRMs are collectively exploiting a significant loophole in U.S. listing regulations."

Nevertheless, the flow of Chinese listings into the U.S. market has virtually frozen in recent years.

The aggregate market capitalization of U.S.-listed Chinese companies fell 72 percent in 2011 and 2012, according to a separate study by McKinsey & Co. earlier this year.

The McKinsey report noted that delisting of Chinese companies is not purely a U.S. phenomenon.

"Since 2008, around one in ten Chinese companies listed in Singapore has also been delisted or suspended," it said.