Uncovering of fake accounts at CFI units again highlights risk of China firms

By JEAN CHUA
REPORTER

JUST as the dust has settled on China Aviation Oil - and its massive derivative trading losses that it tried to hide from investors - another Chinese company has dropped its own bombshell. Several years of dodgy accounts and possible false information in its IPO prospectus are just some of the problems found at China Food Industries (CFI), which must now restate its post-2002 earnings.

Last Thursday, Ernst & Young said that two subsidiaries of CFI had falsified their accounts, inflated profit figures, overstated inventory and faked orders. Junan Hengxing Foodstuff and Shandong Xinquan Grain & Oil had fictitious sales that came up to 21.6 million yuan (S$4.3 million), for which CFI now has to make provisions.

The scandal at CFI is just the latest in a string of such bad news that has hit China companies listed here. Earlier this year, China-based Zhongguo Jilong Ltd warned that its performance for the fourth quarter ended Dec 31, 2005 will decline compared with the third quarter ended Sept 30, 2005 and the fourth quarter ended Dec 31, 2004. Its subsidiaries did not perform as expected, it said.

New Lakeside Holdings, which reported a 66.17 million yuan loss in H105, issues warnings for H205 and H106. Sinobest Technology Holdings also issued profit warnings, and so did CFI.

CFI said that it was because pig prices were falling and that the Agri-Food and Veterinary Authority of Singapore imposed a ban which affected its meat processing and food distribution segments. The list goes on.

The current problems at CFI seem to go beyond mismanagement or negligence. Besides finding the fake accounts, the auditors also found that three blocks of land used for pig operations may not be owned by CFI. CFI may also have overpaid for factories and ended up guaranteeing another company's loans. They also discovered that fake transactions may have been created to make the books look good for its listing on the SGX in September 2003.

As of yesterday, the CFI stock is still trading on the SGX, after CFI sought a lifting of suspension late last week.

Besides raising questions about the reliability of the information that investors have when deciding on the merits of a stock, the case also casts a bad light on the sort of due diligence that has been done at the IPO stage - in CFI's case, in 2003.

This case reminds us of the need to be extra vigilant when it comes to investing in China stocks; the risks are well known. The management of the company is often far away, the level of corporate governance and transparency could be low, financial figures may not be reliable, and business operations may not be very clear.

To be sure, the market operates on a caveat emptor principle. Companies are required to disclose the risks that investors undertake when they buy a stock. And the buyers, armed with this information, bear the consequence of investing themselves.

But this can only apply when disclosure is fact-based. If there is no basic assurance that the information in an IPO prospectus is factual, then what sort of protection do investors have? As a rule, the SGX does not discuss its dealings with listed companies, but it would help to have a clear policy with regards to cases like CFI. If there is no assurance that disclosure is based on facts, then investors should at least have the peace of mind that something will be done about wrong-doers.