Case study on accounting fraud of U.S.-listed Chinese companies

Abstract

During the period from 2009 to 2013, 76 out of 848 U.S. federal securities class action litigations were against Chinese companies listed in U.S. markets. The U.S. Securities and Exchange Commission (SEC) has also initiated more and more investigations into accounting fraud of U.S.-listed Chinese companies during recent years. This paper seeks answers to the following questions: what kinds of accounting fraud are those companies usually involved with? How did they commit such fraud? Are there any common indications that we could identify from those companies and could be used as red flags for accounting fraud? Using a case-study method, I analyze three Chinese companies: RINO International Corporation, Universal Travel Group, and ShengdaTech, Inc. I explore management issues and the various means that these three companies used in their fraudulent behaviors. The major part of this paper comprises three case studies, each of which includes a brief introduction of company background and industry and business discussion, followed by analysis of key management and accounting issues. Together with evidence and clues from other companies, I identify three major sets of characteristics that emerged in my study of these companies involved in accounting fraud, including: 1) low integrity of higher management, weak corporate governance, and internal control deficiencies; 2) suspicious corporate transactions and potential mechanics of how fraud was committed, including overstated revenues, unusually high cash balances and accounts receivable balances, abnormally higher gross profit margins or lower expenses, and undisclosed related party transactions; and 3) external warning signals from auditors and from inconsistent numbers between SEC filings and filings to Chinese regulators.