Chinese Companies and Accounting Fraud: Lawsuits on the Rise

The number of securities class action lawsuits against Chinese companies is increasing. The reason – serious allegation of accounting fraud.

In early April 2011, four major lawsuits were filed against China Electric Motor, Inc.; Advanced Battery Technologies, Inc., China Intelligent Lighting and Electronics, Inc.; and China Century Dragon Media. The allegations against these companies relate to accounting misstatements and misrepresentations, failure to report and disclose related transactions, false statements about investments, and false financial information provided to auditors. The lawsuits name some of the directors, underwriters and auditors as defendants.

These recent lawsuits join many others which have been filed. Close to forty lawsuits alleging improprieties by Chinese companies have been filed.

In a report dated March 14, 2011, the Public Company Accounting Oversight Board raised concerns about accounting and auditing standards at Chinese companies which have conducted IPOs in the US or have become US publicly traded companies through reverse mergers.

The Board raised audit quality concerns in certain audits in which U.S. registered accounting firms performed audits by having most or all of the audit performed by another firm or by assistants engaged from outside the firm without complying with Board standards applicable to using the work and reports of another auditor or supervising assistants.

For example, in one instance described in the report, a U.S. registered accounting firm retained an accounting firm in the China Region, and the audit procedures performed by the other firm constituted substantially all of the audit procedures on the issuer's financial statements. The U.S. firm's personnel did not travel to the China region during the audit, and substantially all of the audit documentation was maintained by the firm in the China Region. The Board also observed situations in which the U.S. registered firm's involvement in the audit work performed by the consultants was insufficient for the firm to assert that the audit provided a reasonable basis for the firm's opinion on the financial statements.

The accounting industry expects more lawsuits to be filed against Chinese companies, directors and auditing firms.