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Chinese firms' missing $6 billion tests regulators' resolve

May 17, 2019

SHANGHAI/SINGAPORE (Reuters) - Cash is considered among the hardest assets for a company to fake, which is why the disappearance of a combined $6.1 billion from two Chinese companies has dumbfounded investors and forced regulators to take action.

Drugmaker Kangmei Pharmaceutical Co Ltd, a constituent of MSCI’s global indexes, in April said an "accounting error" led it to overstate cash in 2017 by 29.94 billion yuan ($4.4 billion). This month, Kangde Xin Composite Material Group Co Ltd, a producer of high-polymer materials, said its auditor could find no trace of the 12.21 billion yuan that it said it held in a bank deposit.

Regulators are investigating both cases and neither company has offered detailed explanations for the missing billions.

Weak governance has long been a black mark against mainland Chinese companies. Yet these cases have still stunned many investors as they involve straightforward cash, and because the sheer size of the disappearances is equivalent to more than half the two groups’ combined market capitalization before they disclosed the issues, triggering calls for tougher punishment for any corporate wrongdoing.

"If you tell me fish in a pond disappeared, I probably would buy the story... Tens of billions of deposits missing, that’s a bit unthinkable," Liu Enqi, vice head of Bank of Nanjing Co Ltd, told Reuters. "If such things happened in the U.S., someone would be jailed."

Pan Jiang, chief executive of asset manager Shanghai V-invest Co, said the cases were "beyond description".

"If regulators just let bad guys walk away, it would be a huge blow to investor confidence," he said.

Officials appear to be listening. China’s top securities regulator, Yi Huiman, told a conference on May 11 that “those who did bad things must pay the price”. The chairman of the China Securities Regulatory Commission (CSRC) also vowed to tighten scrutiny of corporate governance and push for tougher punishment.

Shi Donghui, a senior researcher at the Shanghai Stock Exchange, at a seminar this month said the bourse would “resolutely” delist any companies found to have seriously violated disclosure rules.


Accounting issues take place the world over. When it comes to manipulation, common ploys include inflating asset values, faking customers and overstating money owed. Companies also face more straightforward crimes such as theft.

But cash, sitting in bank accounts, is low on that list. Any big-sum cash fraud would be tough to pull off without help from bankers or auditors, said accounting consultant Ma Junsheng.

Rose Zhang, a partner at Zhong Xi, an accounting firm that audits over 25 China-listed companies, said collusion was likely in cases of disappearing cash because “it is impossible for deposits to vanish out of the blue”.

Kangmei disclosed its issue on April 30 and has said almost nothing beyond its initial diagnosis of “accounting error”. It said China’s securities watchdog was investigating the matter. Kangmei’s auditor GP Certified Public Accountants was also put under investigation, according to local media reports and the auditor.

Kangde Xin also disclosed a CSRC probe. In a series of statements this month, it said it did not exclude the possibility that its cash was appropriated by controlling shareholder Kangde Group. It is also said it was seeking to sue deposit holder Bank of Beijing Co Ltd.

Kangde Group’s chairman, Zhong Yu, has been detained, the police said in a separate statement without elaborating.

Kangde Xin declined to comment further when contacted by Reuters. Repeated calls and a text message to Bank of Beijing went unanswered. Neither Kangde Group nor the China Banking and Insurance Regulatory Commission immediately responded to requests for comment. Reuters could not reach a representative for detained shareholder Zhong.

Kangmei did not immediately respond to a request for comment. GP declined to comment.


The scale of the incidents has sparked calls for China to crack down on corporate wrongdoing.

Under securities law, a listed company that makes false disclosure can be fined up to 600,000 yuan, while the criminal law states those who conceal or intentionally destroy accounting records can be imprisoned for up to five years and fined up to 200,000 yuan.

“The amount of the fine cannot adequately compensate investor losses caused by corporate fraud,” said Xie Lianjie, a partner with Beijing Yingke Law Firm Shanghai Office. His team was contacted by more than 100 investors who lost money in the two stocks following the missing money disclosures.

In addition, China does not have a mechanism for group legal action - famously embodied by U.S. class-action lawsuits - making it expensive for small investors to pursue companies for damages.

“It’s like a war between ants and elephants,” said Xu Caiyuan, an activist investor.

Jia Wu, U.S.-based accounting professor at University of Massachusetts, Dartmouth, said China needs an equivalent to the U.S. Sarbanes-Oxley Act of 2002, which closed a series of accounting and auditing loopholes and made executives personally liable for the accuracy of financial statements.

“You need to put wrongdoers behind bars,” Wu said. “You need a powerful deterrent.”

Last year, China ranked 10th in a widely followed regional ranking of corporate governance, far below nearby India, and above only Indonesia, the Philippines and South Korea, according to the report by brokerage CLSA and the Asian Corporate Governance Association. Among categories measured, China scored particularly poorly for management discipline, independence from controlling shareholders, and for transparency - a key issue in the Kangde Xin and Kangmei cases.

“If information in this market is inadequate, and fake, there’s no basis for fair pricing,” said Hong Yan, professor of finance at the Shanghai Advanced Institute of Finance. “That would make the market a casino.”

Reporting by Samuel Shen in SHANGHAI and Shu Zhang in SINGAPORE; Additional reporting by Cheng Leng in BEIJING; Editing by Jennifer Hughes and Stephen Coates


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