A new storm is brewing in the accounting world, this time centred around mainland firms listed on the Hong Kong stock market.
During the busy corporate earnings season that has just ended, several Hong Kong-listed firms surprised investors with the news that they are delaying their results announcements or that their auditors had resigned. Some of the firms are household brands on the mainland and were widely believed to have been adhering to good business practices.
Last year, the spotlight fell on a number of mainland high-technology and internet companies listed in the United States, including Jiayuan. com, an online match-making website, and Longtop Financial Technologies, a software provider. Scrutiny of mainland firms' accounting standards intensified last June when short-seller Carson Block alleged forestry company Sino-Forest had overstated its assets and cash balances. Now the attention has shifted to retail and consumer goods companies, including popular fashion brand Ports Design, listed in Hong Kong. Many of them are small and medium-sized businesses (SMEs).
'The number of auditor resignations from mainland SMEs in the first quarter of this year has already reached the total of last year,' says Arthur Kwong, the head of Asia-Pacific equities at BNP Paribas. 'More could come as auditors are likely to be less and less tolerant of grey areas given the negative market perception' of such companies.
A credit crunch on the mainland that is particularly affecting SMEs, coupled with a slowing domestic economy, is making it more difficult for some companies to make ends meet. Among the hardest hit are purveyors of goods such as household appliances, hit by a weakening housing market, and clothing, with sales damped by rising prices. Moreover, industry analysts say, for companies that have been cooking the books, economic and industry downturns make it harder to hide malfeasance.
'The retail industry on the mainland started to slow down in the second half of last year,' says Forrest Chan, an analyst at CCB International Securities. 'A large number of the listed companies in the retail industry are small and medium-sized private enterprises, which are more likely to be tight on cash. This may explain the reason why they are running into accounting problems.'
Late last month, Daqing Dairy, a mid-sized milk producer listed in Hong Kong, said Deloitte Touche Tohmatsu recently resigned as its auditor because of a disagreement over the accuracy of the company's financial statements.
According to an extract of a letter from Deloitte to the company, which was provided to the stock exchange on March 29, the auditor's concerns included 'certain milk procurement transactions brought to the attention of management and acknowledged by them to be fraudulent.'
Trading in Daqing's stock has been suspended since the company told HKEx it planned to release 'price-sensitive' information in connection with the resignation of its auditors, and its earnings statement has been delayed.
These developments followed an announcement on March 15 by mainland children's-garment maker Boshiwa International that Deloitte was resigning as its auditor because it was dissatisfied with certain information and explanations the company had supplied.
At issue, Boshiwa says, is 392 million yuan [HK$482 million] in prepayments to a supplier. Again, trading in the HKEx-listed company's shares has been suspended and its full-year earnings announcement delayed.
Credit Suisse analysts Eva Wang and Kenny Lau said in a report for the bank's clients that the resignation of Boshiwa's auditor was 'a surprise to the market and could negatively affect investors' confidence in the company's corporate governance'.
Last year, Deloitte's Shanghai office ran into trouble with the US Securities and Exchange Commission (SEC), which asked it to hand over its auditing documents for a client, New York-listed Longtop Financial. Deloitte resigned as the company's auditor but refused to fully cooperate with the SEC, citing China's state secrecy laws as part of the reason why it could not provide the documents required by the US regulator, according to a source with knowledge of the matter.
'After the Longtop case, Deloitte has apparently become tougher on some of its clients when doing their auditing work, I think this may explain why you see Deloitte quit two of its mainland clients within a month,' said the source.
Deloitte declined to comment further on the Longtop case as well as on its other former clients.
Meanwhile, fashion retailer Ports Design, which was established in Canada but is now headquartered in and listed in Hong Kong - and which derives the bulk of its revenue from the mainland - also said last week it had to postpone announcing its 2011 results beyond the mandated deadline of March 31 because its auditor KPMG had asked for more time.
Ports' announcement also caught analysts by surprise, and the company hasn't yet provided an explanation.
'These are pretty famous brands on the mainland and if they have accounting problems, then people will naturally ask about other little-known companies,' added a senior executive at an accounting firm who asked not to be identified as he isn't authorised to speak to the media.
Other Hong Kong-listed companies, including Shirble Department Store of Shenzhen and Ausnutria Dairy of Hunan, have recently delayed reporting their 2011 results.
Corporate governance has long been a troublesome issue on the mainland, even going back before the economic reforms of the late 1970s. Several major state-owned enterprises, including Bank of China (Hong Kong), have been caught up in bribery- and corruption-related cases.
However, it is more frequently SMEs, in particular family-owned businesses, which are involved in accounting irregularities and therefore big state banks are hesitant to extend credit to them. Listing on a stock market is another way for them to raise funds. During Vice-Premier Li Keqiang's visit to Hong Kong last August, he noted that the central government would support more mainland companies listing in Hong Kong. Scholars and analysts called on the city's stock market regulator to keep a close eye on the mainland's accounting standards.
Commenting on the latest auditor resignations, Sophia Kao, chairwoman of Hong Kong's Financial Reporting Council, which regulates auditors, said it was putting certain mainland companies on a 'watch list' and would work with other government bodies to decide how to address the issue.
Since early last year, mainland-based companies listed in Hong Kong have been allowed to use either Hong Kong-based auditors or mainland auditors approved by the Ministry of Finance. Previously all Hong Kong-listed companies were required to use a Hong Kong-based auditor. The rule change prompted some Hong Kong lawmakers to voice concerns about the difficulty of Hong Kong's market regulators policing mainland auditors. They also fear mainland accounting firms may apply less stringent auditing standards, which could mask unscrupulous dealings, and they worry about increased competition for Hong Kong auditors from their mainland counterparts.
Additional reporting by Celine Sun in Beijing